Three Pillars Of An Effective Risk Management Program

Some design professionals may view risk management as a synonym for professional liability insurance, to be addressed once a year at renewal. In reality, insurance is only one component of a much broader and more intentional risk management program. Firms that manage risk effectively understand that professional liability exposure is created long before a claim is made and, just as often, during the day-to-day execution of a project.

An effective risk management program rests on three interdependent pillars: (i) insurance, (ii) contracts, and (iii) people. When these three components are aligned, architects and engineers are better positioned to control exposure, reduce claims, and protect the long-term value of the practice. When they are misaligned, even well-run firms can find themselves facing unnecessary and costly disputes.

Insurance: Financial Backstop, Not the Strategy

Professional liability insurance is best understood as a safety net for a firm’s overall risk management portfolio. It is intended to serve as a backstop in the event of a loss, and not as a substitute for thoughtful contracting or disciplined project execution. The amount of coverage a firm procures will be driven by the size and complexity of the projects it undertakes, and for most firms it represents a significant annual expense.

Because of that cost, good risk management practices focus on trying to cap liability on individual projects at or below the value of the insurance procured. Once insurance is in place, firms should also understand and take advantage of the benefits that exist within the policy, rather than viewing coverage as something to be avoided unless absolutely necessary.

Prudent design firms avail themselves of coverage under their professional liability policies when claims, or circumstances which may give rise to a claim, occur. Whether it relates  to prompt reporting of claims or seeking pre-claim coverage for circumstance which could escalate into a claim if left unaddressed, prudent design professionals leverage their professional liability policies to maximize the benefits received for the premiums paid.

Contracts: Defining and Governing Risk Tolerance

If insurance is the backstop, contracts are the primary tool for defining, allocating, and capping risk. An effective contracting strategy begins with a firm-wide understanding the firm’s risk tolerance. Ownership should identify what risks the firm is willing to assume, and price its services accordingly. The alternative – making ad hoc decisions on a project-by-project basis regarding risk tolerance – can undermine a comprehensive risk management strategy.

Many design firms choose to limit their services within a limitation of liability tied to their professional liability insurance, intentionally avoiding uninsurable exposures. Other design firms identify certain contract terms that are deal breakers (e.g., insurability of contract terms, waivers of consequential damages, no person liability provisions, no third-party beneficiary provisions, etc.), either firm-wide or based on project type, and require those provisions in every contract they sign. What matters most is consistency. When ownership is aligned on acceptable risk, decision-making becomes intentional and repeatable, rather than dependent on the individual judgment of the principal leading a particular project.

Risk management through contracts must also operate both upstream and downstream. Prime design professionals assume significant vicarious liability for their subconsultants, yet subconsultant agreements are often treated as an afterthought. When acting as a prime design professional, a comprehensive risk management program recognizes that a downstream contract which does not properly align with the prime agreement—or fails to impose appropriate obligations on the subconsultant—can impose unanticipated risks on the prime design professional.

An effective risk management program includes standardized approaches to both prime contracts and subconsultant contracts, ensuring that scope, standard of care, indemnification, and insurance obligations are aligned throughout the project team.

People: Execution Is Where Risk Is Created—or Controlled

The third pillar, people, is where a risk management program either succeeds or fails. This is the execution layer of the program. Even the best insurance and the most carefully negotiated contracts provide limited protection if the project team does not execute in a manner consistent with the firm’s risk management program.

Implementation of a risk management program begins with the people tasked with forming contracts and aligning those contracts to the insurance programs maintained by the design firm. An effective risk management program continues with the education design professional provide by the project team to the clients throughout the course of a project. Design professionals regularly present clients with options, tradeoffs, and recommendations. Risk is reduced when those options are clearly explained and when client decisions are documented contemporaneously. Years later, written records of what was discussed and decided often become the most persuasive evidence that the design professional acted reasonably.

Finally, people are responsible for enforcing the terms of the contracts on a project. During the execution of the project, it is critical that the project team (i) understands the full scope of services, including what is in scope and out of scope, and seeks additional compensation when asked to perform out-of-scope services, and (ii) understands the processes set forth in the construction contract, and advises the owner when deviations from those processes occur. Ignoring contractual rights can result claims that might otherwise have been avoided through prompt enforcement of contractual rights.

Aligning the Three Pillars Heading into the New Year

Insurance, contracts, and people are not standalone components of a risk management program. An insurance program cannot fix a bad contract. A well-drafted contract fails without disciplined execution. And even the best people need the protection of insurance when things go wrong. As firms look to the year ahead, now is the time to assess whether these three pillars are aligned. Design firms which take a proactive, intentional approach to risk management—one that integrates insurance strategy, consistent contracting practices, and disciplined project execution—are better positioned to protect their balance sheets, their reputations, and their long-term viability in an increasingly complex professional environment.

Jonathan C. Shoemaker is an attorney at Lee/Shoemaker PLLC, a law firm devoted to the representation of design professionals in DC, Maryland, and Virginia. The content of this article was prepared to educate related to potential risks but is not intended to be a substitute for professional legal advice.